Permanent Health Insurance clauses: the hidden risks employers don’t see coming

Permanent health insurance (PHI) is often included in employment contracts as a reassuring benefit, something that signals support if illness strikes. Yet in practice, it’s one of the easiest benefits to get wrong. For that reason, many employers choose not to offer PHI at all. Those that do, however, need to understand that it can create liabilities extending well beyond the employment relationship if the contractual drafting and insurance arrangements are not carefully aligned.

A recent case shows just how significant the consequences can be.

In McMahon v AXA ICAS Ltd, an employee became entitled to PHI benefits after a period of illness. The employer had promised the benefit in the contract but had never actually put the insurance policy in place. They later dismissed the employee on grounds of ill health, seemingly drawing a line under both the employment and the obligation to provide PHI. Unfortunately for them, it didn’t work.

This happened in Scotland, and the Court there decided that the obligation to provide PHI could continue despite the dismissal and that the payments could even qualify as “wages” under the Employment Rights Act 1996. In practical terms, that meant the employer could still be required to make the PHI payments even after employment had ended.

The decision is from the Scottish court and is therefore not binding on courts in England and Wales. However, it interprets UK-wide legislation and applies well-established principles, meaning it may well be considered and followed here too.

PHI isn’t “normal pay”

PHI does not operate like salary or bonus. It is not paid in exchange for work done and it is not dependent on the employee continuing to provide services. It exists for the opposite situation: when the employee cannot work. As a result, the obligation can sit alongside the employment relationship rather than ending with it. Dismissal may bring the contract to a close, but it does not necessarily extinguish every obligation within it.

Does someone have to remain an employee to qualify for PHI?

Many PHI policies include a condition that the individual must remain an employee in order to receive the benefit. That creates a tension. If the employer dismisses someone who is receiving, or about to receive, PHI, the insurer may refuse to pay because the employment has ended. At the same time, the employee may still have a contractual right to the benefit depending on the drafting in the contract.

The result is a financial gap, and it is often the employer who ends up filling it.

Dismissal isn’t a shortcut

There is a consistent theme running through the case law in relation to PHI. Courts have long been uneasy about employers offering income protection on the one hand while retaining the ability to remove it the moment it becomes relevant.

As recognised in Aspden v Webbs Poultry, a benefit designed to protect employees during illness risks becoming meaningless if employment can simply be terminated to avoid paying it. That thinking continues to influence how tribunals approach PHI cases today. In practical terms, using dismissal to sidestep PHI obligations is unlikely to be a reliable solution.

Earlier English authorities also established that employers may remain liable where PHI benefits are promised contractually but the insurance cover is not put in place properly.

The modern PHI drafting approach

Modern PHI drafting has many contracts now expressly stating that employment may be terminated even if doing so brings entitlement to PHI benefits to an end. Carefully drafted clauses along these lines can be effective, particularly where the contractual entitlement is expressly limited to the terms of the underlying insurance policy. However, no drafting is likely to assist where the employer has promised the benefit but failed to obtain or maintain the insurance cover in the first place.

When the contract creates more risk than the policy

This is where many employers are caught out. There is a fundamental difference between promising to provide PHI through an insurer and promising the benefit itself. If the contract is not tightly drafted, and clearly linked to a specific policy and its terms, it can result in the employee being entitled to the benefit even if there is no insurance to cover the cost.

That becomes particularly risky when policies change. If an employer switches insurers or amends the terms, an employee who no longer qualifies under the new policy may still rely on the original contractual wording. At that point, the employer, not the insurer, may be left carrying the cost.

The take-away message for employers

PHI is not just another employee benefit. It is a potentially long-term contractual commitment with significant financial consequences.

Employers who choose to offer it need to ensure that:

• the insurance is actually in place and kept under review
• contractual wording is tightly aligned with the policy terms
• termination provisions are carefully drafted to avoid creating unintended standalone entitlements.

Otherwise, employers may find themselves funding a benefit they assumed an insurer would cover.

If you need support in relation to any aspect of employment contracts within your business, please get in touch.

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This article aims to supply general information, but it is not intended to constitute advice. Every effort is made to ensure that the law referred to is correct at the date of publication and to avoid any statement which may mislead. However, no duty of care is assumed to any person and no liability is accepted for any omission or inaccuracy. Always seek advice specific to your own circumstances. Fraser Dawbarns LLP is always happy to provide such advice.